Investor Education

Emotion can be the enemy of investing

In a bull market, investors tend to get excited and buy at the peak of the cycle, spurred on by media hype and anecdotal stories of killer returns. But when the market weakens, fear takes over and nervous investors sell at the bottom.

It’s a poor strategy to build wealth, and that’s why emotion should stay out of investing, says Craig Senyk, a director and portfolio manager at Mawer Investment Management Ltd.

“Investing should be boring,” says Mr. Senyk. “We’re big believers that the more you can remove the emotion, the higher the probability that you’re going to be successful. But that’s obviously easier said than done. It’s pretty much human nature to be excited or nervous when putting your money at risk.”

To minimize the impact of emotion on your investments, it’s important to put a process in place that you follow no matter what the markets are doing, says Mr. Senyk. To that end, every investor should have an investment policy.

“Put it down on paper: What is the goal for this money? When are you going to need it and how much risk are you comfortable with? How much money are you willing to lose? That will lead you to determine how much you can invest in stocks, as opposed to other things like GICs (guaranteed investment certificates), bonds, or cash. Once you’ve gone through that process, you can start taking a look at what equities to buy.”

By having an investment policy, investors can resist impulsively jumping ship when markets get volatile.

“You’ve written it out in normal times, when emotion isn’t influencing your decision. So if you have on paper that you’re comfortable investing 60 per cent in equities, you should stick to that policy, no matter what the markets are doing,” says Mr. Senyk.

Your investment policy should be reviewed annually or when there’s a major life event, like getting married, getting a new job, or having a child, says Mr. Senyk. For example, if you know you’ll need money for something major (like a down payment on a house), it might make sense to create a new goal and change your investment policy to reflect that purchase.

As well, investors should never invest more than they can afford to lose, says Mr. Senyk. “Each individual investment shouldn’t be so great that it’s going to destroy your overall wealth. You don’t want 20 or 30 per cent of your portfolio sitting in one stock, like many people did with technology and oil and gas stocks. You really have to watch your overall risk profile in terms of your exposure to certain companies, certain sectors, and certain countries.”

A financial advisor can help you with those choices because “they should be an unbiased third party,” says Mr. Senyk. “Hopefully, they’ve been there before and have seen the benefit of sticking with the plan over the long term, as opposed to making rash decisions at the wrong time.”

Jeff Tjornehoj is head of Americas research for Lipper, a Thomson Reuters company that supplies mutual fund information and analytical tools, and he agrees, that if you’re looking for excitement, “buy a ticket to Las Vegas.”

Rarely does an investment idea come along that pays off very well with a low level of risk, says Mr. Tjornehoj. “That’s why we always encourage investors to understand their own risk tolerance, do their homework, and find funds that are suitable with that risk profile and be prepared to let that play out over many years. There is no get-rich-quick solution out there, and if there was, we’d all be wealthy and living on an island.”

When markets are turbulent, diversification can help mitigate that impact, keeping you from making hasty decisions, says Mr. Tjornehoj. “You’re preparing your portfolio with the right mix of funds and asset classes so that when bad times do come along, and they will, you’re not overexposed to the weakest areas of the market. It may be the case that stocks tank for a few years. That doesn’t mean you shouldn’t own stocks, but if you don’t think you have the horizon to wait out the storm, then maybe you should be in less risky stocks or less stocks than a younger person would have in their portfolio.”

Mr. Tjornehoj also suggests this rule of thumb: if everybody else is doing something together, that might be the signal to do something different.

“You really want to buy into the market when everybody else wants to sell,” he says. “Everybody can get wealthy by buying low and selling high, but we find a lot of investors follow the emotions of the herd and do the opposite. They sell when everyone else is selling because they fear the fall, but that’s why you keep some cash on hand. You want to be able to buy into those moments when all looks hopeless.”

Mr. Senyk advises investors to keep turnover low. “Our approach has a typical turnover rate of 10 – 20 per cent,” he says. “On average, we’re holding a security in a portfolio for 5 to 10 years. Diversification is important too, but it’s a balance. You can be under-diversified by having too much in one sector. But over-diversification can occur when you own too many mutual funds. You’re overpaying on fees and you look just like the market, so you’re paying too much for the average.” But what if you’re approaching retirement and feel like you’re far behind, and the slow and steady approach just won’t work?

“The problem with the go-for-broke approach is you usually end up broke by trying to make up for it. The story that haunts me to this very day is a couple approaching retirement that I had in 1999 and they said, ‘Craig, we’ve been happy with your returns but we’re looking at what people are making with technology stocks and we want to go for it.’ So they left and a year later, I’m pretty sure they lost everything.”

Mr. Senyk says much of his work at Mawer is about helping people reset their expectations.

“It’s unrealistic to think you can consistently earn double-digit return within your portfolio. We’ve been blessed with that over the last five years, but over the long term it’s unrealistic to think that’s going to continue,” he says.

And if monitoring your investments feels like watching paint dry, you’re on the right track.

“If you’re looking for excitement, a lot of my colleagues do extreme sports,” adds Mr. Senyk. “That’s where they get their excitement, not when they come in to work.”